Energy Investing Guide: 3 Stocks to Buy, 3 to Avoid

Energy, which was the strongest S&P sector performer in 2016 with a market-thumping 24% return, has not exactly had a great start this year – the Zacks Oil-Energy sector is down 9.9% year-to-date versus 11.5% growth for the broader S&P 500.

Compare this to 16% growth during the same period last year and one wonders whether the stellar run for the sector is over.

The sector has been under immense pressure over the last few months thanks to concerns over growing U.S. supply and falling refinery demand post Hurricane Harvey.

At the crux of the matter is the rising flood of U.S. shale-driven production. Now at a financial equilibrium, the shale firms are putting more rigs and employees back to work. Throughout the downturn, producers worked tirelessly to cut costs down to a bare minimum and look for innovative ways to churn out more oil from rock. And they managed to do just that by improving drilling techniques.

With these efforts, many upstream companies have repositioned themselves to adapt to the new $50 oil reality and even thrive at those prices. In other words, while OPEC's moves to trim output and rebalance the demand-supply situation has stabilized the market to a large extent, in the process it has incentivized shale drillers to churn out more. As per Energy Information Administration’s (“EIA”) latest inventory release, U.S. production rose to 9.5 million barrels a day – the highest level in more than two years. This was prior to the temporary drop in U.S. Gulf of Mexico oil volumes on account of disruptions from Harvey.

Meanwhile, as Harvey tore through the Texas Gulf Coast, workers in the U.S. oil industry had to evacuate production facilities and shut down refineries. This, in turn, triggered the biggest disruption in nationwide energy supplies in years.

The United States has major refining infrastructures along the Gulf of Mexico (“GoM”). According to the EIA, more than 45% of domestic oil refining capacity are located in the GoM.

With deluge and floods in the aftermath of Harvey knocking out a major chunk of domestic refining capacity, crude demand was significantly curbed. This again led to lower oil prices.

But it’s Not All Bad News for Energy

But the scenario isn’t as bad as it may look.

Oil has rebounded from its multi-year lows reached in 2016 and while the commodity may not be at a level many thought it would be at this time of the year, even at today’s prices certain companies are in a position to earn profits. And while we cannot run down the chances of the market moving sideways and seeing high volatility, many analysts are not too bearish about oil in the remainder of 2017. Here’s why:

Sharp Inventory Drawdowns: Investors have pinned hopes of recovery over the recent U.S. Energy Department's inventory releases that show multiple weeks of strong inventory draws in the domestic crude stockpiles – pointing to a slowdown in shale output. The nation's oil stockpiles have shrunk in nine of the last 10 weeks and are down more than 70 million barrels since March.

The Shift into "Backwardation": Recently, the front-month Brent contract have shifted into "backwardation" – a phenomenon when near-term oil futures trade at a premium to futures dated further out. Analysts consider this as a bullish signal with the so-called backwardated market helping flush out inventories by eliminating the incentive to put oil in storage.

Fall in Rig Count: According to Baker Hughes, the GE-owned company’s closely watched weekly report, the oil rig count has gone down for a third week in four. This implies that U.S. energy firms are cutting down on their capital investment plans in reaction to low crude prices. Importantly, this is an indicator of lower future production.

OPEC Curbs Are Working: According to the oil cartel’s latest monthly report, OPEC production fell by 79,000 barrels a day in August. This points to the success of the 14-member group’s output curb initiatives and rising compliance levels.

One thing the oil market downturn has taught investors: nobody has much visibility into the future. So, when you think of something as a clear line of sight one quarter, it can soon be overshadowed by an unforeseen event. While the major price correction has resulted in attractive valuations, we nevertheless advise investors to exercise caution while selecting stocks.

With a wide range of energy firms thronging the investment space, it is by no means an easy task for investors to arrive at stocks that have the potential to deliver attractive returns. While it is impossible to be sure about such outperformers, this is where the Zacks Rank, which justifies a company’s strong fundamentals, can come in really handy.

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Based on favorable Zacks Ranks, we have zeroed in on three energy stocks with strong fundamentals and growth potential.

First on our list is Fort Worth, TX-based Range Resources Corp.RRC. Range Resources, a Zacks Rank #1 (Strong Buy) stock, is an independent oil and gas company, engaged in the exploration, development and acquisition of oil and gas properties primarily in the southwestern, Appalachian and Gulf Coast regions of the U.S. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The 2017 Zacks Consensus Estimate for this company is 48 cents, representing some 1,494.9% earnings per share growth over 2016. Next year’s average forecast is 61 cents, pointing to another 28% growth on the back of expanding margins from cost control and capital efficiencies.

TransCanada CorporationTRP, another #1 Ranked stock, looks well-positioned for growth. Based in Calgary, Alberta, the North American energy infrastructure company is the owner of premier pipeline network systems that guarantee. TransCanada’s low risk business model and high-quality assets offers multiple platforms for visible growth.

As a result, the company’s expected EPS growth rate for three to five years currently stands at 10%, comparing favorably with the industry's growth rate of 9.7%.

Houston, TX-based W&T Offshore Inc.WTI is our last pick. The Zacks Rank #2 (Buy) exploration and production company focuses primarily in the U.S. Gulf of Mexico.

W&T Offshore has an excellent earnings surprise history. With phenomenal drilling success in its high value deepwater exploration projects, the company has a 100% track of outperforming estimates over the last four quarters at an impressive average rate of 586.7%.

3 Names to Steer Clear Of

Choosing stocks to dump from your portfolio is equally risky as there are so many to be avoided. At the same time, identifying vicious stocks and discarding them at the right time is the key to shield oneself from big losses or make profits by short selling them. In particular, it would make sense to avoid companies that carry an unfavorable Zacks Rank.

One of the largest independent liquid petroleum products pipeline and terminal operators in the U.S., Buckeye Partners L.P.BPL is a risky bet that ordinary investors should exit.

Struggling with less favorable business conditions and decline in marine terminal capacity utilization, the Zacks Rank #5 (Strong Sell) partnership reported lower-than-expected second-quarter earnings. Moreover, negative earnings estimates have pushed Zacks Consensus Estimate for 2017 down from $3.49 to $3.44 per share over the last 30 days.

San Antonio, TX-based NuStar Energy L.P.NS, a Zacks Rank #4 (Sell) stock, delivered disappointing second quarter results and is witnessing downward revisions in earnings estimates. NuStar is a master limited partnership that engages in the transportation and storage of crude oil as well as refined products in the U.S., the Netherlands Antilles, Canada, Mexico, and the U.K.

Crude's historic decline has undoubtedly impacted the demand for transportation and storage services, which justifies the 5.6% downward revision in 2017 earnings estimate over the last 30 days.

Basic Energy Services Inc.BAS, headquartered in Fort Worth, TX, is a top provider of well servicing rigs and equipments.

Stung by the tepid demand for oil-related services, lower utilization and a competitive market, the #4 Ranked company has a dismal track of missing estimates over the last three quarters.

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